A complaint GPs often have is that they are required to fill in lots of different investor questionnaires, all of which ask for similar information in differing formats. It seems now environmental, social and governance (ESG) disclosure is becoming a widespread concern.
That might not seem like LPs’ problem. But in practice no manager is going to devote the same amount of care and attention to 50 ESG questionnaires that they would to five – so the net result will be a decline in the quality of information that is provided.
A standardized approach to ESG reporting would potentially reduce the amount of re-work required on both sides. But would it actually work in practice?
The glass-half-empty view is that no standardized document will be able to answer all the questions of the most sophisticated LPs.
A number of GPs have already started trying to pre-empt this flood of questionnaires by producing their own ESG disclosure statements, which they distribute to investors during the fundraising process.
But in practice LPs speaking at PEI’s Responsible Investment Forum in June suggested they treated these DDQs – even the ones they produce themselves – merely as a starting point for a deeper dive into the weeds of the portfolio.
“We look at [them], and then we engage with GPs on specific questions – [i.e.] specific to their region, or their way of investing,” Marta Jankovic, senior sustainability and governance specialist at APG Asset Management, said. The standard documents are never an end in themselves, she explained.
On the other hand, one of the biggest problems with ESG is that there’s just such a broad spectrum of engagement and motivations among LPs. The benefit of a standardized approach, like the framework the United Nations-backed Principles for Responsible Investment (PRI) has produced, should be that it encourages GPs and LPs to start setting metrics and sharing information in a more standardized way; and that in turn should make it easier to sell the benefits to those GPs and LPs who remain skeptical.
Limits to standardization
There does however appear to be a limit to just how standardized things can become. LPs fear that if things become too standardized, GPs may begin thinking of their ESG reporting as a box-ticking exercise.
No matter what an ESG report says, GPs should expect “that there are going to be questions” about their ESG efforts and be prepared to discuss them with their LPs, says Jackie Roberts, chief sustainability officer for The Carlyle Group. “That is critical for the industry.”
To that end the PRI intentionally keeps its reporting framework flexible, mostly as a way for GPs to explain exactly what they have done at a company to help differentiate themselves from others.
“The kind of reporting GPs do for us has some standardization but it is pretty light,” elaborates Lorenzo Saa, associate director at the PRI. “It really gets people to think about the issues and ensure certain information is publicly disclosed but it doesn’t force people into a narrow straightjacket.”
A related challenge in standardization is how to account for the sheer diversity within the private funds industry, which includes a range of investment strategies, geographies and investment sizes. Some say standardization then is better achieved by working within different composites of the industry.
“When it comes to reporting on ESG issues within portfolio companies, we prefer to use a systematic approach rather than a standardized one because the nature of the investment differs between GPs,” says Topaz Simply, senior associate at ESG consultancy firm Malk Sustainability Partners. “For example, is this a controlled or minority investment? What sector is it in? What type of operations does it have? Therefore, it is more feasible to have an assessment framework to identify potential issues.”
Roberts echoes the thinking: “When you start talking about rolling up companies and rolling up sectors into a standard, I don’t know how you could at a practical level do that. The next step for PRI is to start matchmaking; saying here is an industry, here is that long list of potential issues, here are the ones most likely to come up for that industry. It’s not perfect but it’s the next step.”
Another reporting challenge is how to speak about something that cannot be easily measured. Some firms successfully tally the environmental triumphs at portfolio companies and linking them to IRR (Kohlberg Kravis Roberts, in particular, has done a good job banging the drum on this), but measuring the decisions taken that relate to the other letters in the ESG acronym aren’t as straightforward. How does a firm tally how many strikes it has prevented by improving working conditions at companies?
Keeping open-ended questions in an ESG reporting template helps to address some of these reporting problems, says Therése Lennehag, a responsible investment director at EQT Partners and chairwoman of the EVCA’s Responsible Investment Roundtable. “The reporting should be a tool to achieve the task you have set out to do. So if you are talking about a standard with a few questions a company needs to answer and then space to articulate and elaborate on with supporting KPIs to put it all into context and demonstrate impact, then I think that is a great thing if people can be given more guidance to that sort of standardized approach.”
It’s that same strategy the PRI wants to take the industry on ESG reporting, says Saa, albeit he is quick to point out that the road to a truly standard reporting template is a long one. “Do we think our reporting framework is a one stop shop? The answer is no, it’s a place to enhance the conversation.”
But as Tanya Carmichael, director of funds at Teachers’ Private Capital, part of Ontario Teachers’ Pension Plan argues: “The landscape is changing very rapidly. There are more LPs than before asking for some understanding of the ESG processes that supplement a GP’s particular strategy. We’re seeing more LPs who were not previously engaged with the discussion around responsible investing come along too.”
Ultimately that is important because the more noise there is from LPs on ESG, the more confidence it will give GPs to spend time on this area.
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